What’s the best way to invest now? How do I dig my family out of debt? Is now the time to buy a house? TODAY financial editor Jean Chatzky, financial expert David Bach, author of “Fight for Your Money,” and CNBC’s Carmen Wong Ulrich offer advice on these issues and more.
Q: My husband and I had about $600K in stocks and bonds (60-40 split) ... and now it's down to $350K. We want to retire in five years. Should we now take our money out of the market and put it in a CD at 2.5 percent and reinvest again at a later time, or ride this thing out? — Kathy, Oregon
Jean Chatzky: The most important thing to remember right now is that you haven't lost any money until you sell. That means if you pull out of the market now, you'll be locking in those losses. If you don't, you can ride it out until the market starts to rebound. Although it doesn't seem like it, five years is a long time, because you don't pull your entire nest egg out during your first year of retirement — the general rule is to pull out about 4 percent each year, adjusting for inflation and market fluctuations. When the market is down, you pull out less or forgo the increase for inflation. When it's up, you can pull out more. A study by T. Rowe Price last year found that retirees who kept their asset allocation at around 55 percent stocks and 45 percent bonds in a bear market, but reduced their withdrawal amounts, did well. Those who panicked and went too conservative hurt their chances of having enough for retirement by pulling out of stocks just as the market was about to recover.
So what you want to do now is focus on saving as much as you can — $150,000 a year is a very solid income, and you should be able to sock a good bit of money away in the next five years. Then, you reassess. You may find that at that point, the market has rebounded and you've amped up your savings enough to be right where you want to be. Or you may find that you have to work a little longer. Working a few more years and delaying retirement is the best way to make your retirement savings last longer.
Q: My household has four major debts — one mortgage, two auto loans and one student loan. We took advantage of the first-time home buyer's tax credit this year, and now are wondering what to do with this money. I am upside on one of the car loans. Should I pay down the loans or just continue making the payments on the loans and put the money away?— Greg, Pennsylvania
Carmen Wong Ulrich: Greg, a lot of your answer has to do actually with keeping out of credit card debt ... But first, what are the interest rates on your student loans? If you've got your degree and the rates are low, don't be in any rush to pay them off. These loans are an example of “good” debt — an investment in you and your future. You're making more money at your job because of this debt, and with interest rates at or below 7 percent, it's not costing you too much to have the loan. However, as your auto loan is at 8 percent and you're underwater/upside-down on the car — which is a depreciating asset — work on paying this down as much as possible. But, before you even pay down that car, prevent yourself from getting into credit card debt by making sure that you first have a solid emergency fund of several months’ worth of living expenses. Only if you have that fund built up, work harder on paying off the car loan, but if you can't do both, stash your cash first, and make sure you pay on time every time for every loan you have. And don't be in any rush to pay your mortgage ahead of time; 6.5 percent may seem high in this market but again, mortgage debt at or below 7 percent over 30 years is a historical bargain. So just continue to pay it on time and focus instead on saving, both your emergency fund and for your retirement and any other goals, so you can stay out of credit card debt.
Q: I have been recently displaced. I have budgeted out my severance five to six months. I have health coverage, at the employee rate, for four months. I will start full COBRA coverage at the end of four months. Is that when the 65 percent subsidy for COBRA will start? — Sue, New York
Jean Chatzky: This is going to help a lot of people. It's a new subsidy that pays for 65 percent of your COBRA. To qualify for this subsidy, you must have been involuntarily separated from your employer between September 1, 2008, and December 31, 2009. If you lost your job during that time period and you turned down COBRA because you didn't think you could afford it, it's not too late: You have an extra 60 days to elect to receive COBRA and get the subsidy.
So Sue, we called the IRS about this and they said that the answer to your question depends on how your COBRA coverage is handled by your former employer. If the company dates the beginning of your COBRA coverage as your last day of work, then your subsidy will kick in during your four months of severance. You'll pay 35 percent of the employee rate, and your employer will pay 65 percent, as well as the employer share that he already agreed to pay for that four-month period. After that, you'll pay 35 percent of the full COBRA premium and your former employer will pay 65 percent for the next five months.
If, on the other hand, the company dates the beginning of your COBRA as the last day of your severance, your subsidy period will begin then. For the next nine months, you'll pay 35 percent of the full premium and your former employer will pay 65 percent. So you should ask them. They may be willing to work with you to make the most of this subsidy.
One last note: The subsidy phases out for individuals with a modified adjusted gross income of more than $125,000, or $250,000 for joint filers. It lasts for nine months.
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Q: I am 33 and my husband is 35. We just had a daughter and want to know how to begin saving for her future. We have a house with a fixed interest rate we can afford. We took out a $50,000 home equity loan a few years ago to do some remodeling. We have no credit card debt. We owe a little on a car and I have about $40,000 in student loans — the payments have been deferred while I have been in school. But I will have to begin paying them when I graduate with my Ph.D. next year. My husband contributes the maximum matched by his employer to his employee savings plan (5 percent). We have about $15,000 saved for retirement so far. I am nervous about our lack of savings. What percentage of our income should we be saving each month? And what's a smart place to put money when you're saving long-term? — Ramona, Florida
David Bach: First off, I'd like to know why the student loan is coming due when you graduate ... They usually have a much longer term. What kind of student loan do you have? Have you ever refinanced the student loan?
Now, the good news is that you are already paying yourself first by contributing to the Employee Savings Plan. What I tell people is that they should save the equivalent of one-hour-a-day of your income, which comes out to be about 12.5 percent of your gross income. The minimum you should save is 10 percent of your gross income. Your gross income is what you make before taxes.
So your husband is paying into his 401(k) just what his employer matches — which is 5 percent (per Ramona), but the max amount the employer matches is not the max amount you can give. You should really try to get your monthly contribution to the maximum you can contribute, regardless of what your employer is matching. So that's closer to 10-15 percent. You should max out your 401(k) and in most plans, that is about 15 percent. There are three reasons why you want to max out your 401(k) contribution. First, it is automatic savings. It goes directly into your savings account. Second, it is tax deductible. Every time you put a dollar into that savings account, you are not playing taxes on it. Third, it grows tax-free and you can borrow against it. It is really the first place you should put your money.
Also, I would say that you need to get more money in your emergency savings account. You should be trying to put 5-10 percent of your income into a regular savings account each month. Find the best rate you can — about 2 percent right now. Right now I tell people, having six months to a year of expenses saved is the ultimate security goal.
As for long-term educational savings for your child, I tell people that the moment a child is born, open up a 529 Plan — a college savings plan. I would be saving a couple hundred dollars every paycheck into that plan. You are going to need at least $150,000 by the time the child is 18 years old. You do pay taxes on the money before you put it in, but it grows tax-free and the profits come out tax free if the money is used for educational purposes.
Q: Is there any type of help from the stimulus package or housing bill to help homeowners that are making their payments on time but can't take advantage of their interest rates? We bought our house at a peak in the market in May 07 and now the appraised value has dropped by almost $50,000. — Shawn
Carmen Wong Ulrich: Shawn, the Housing Plan has two parts: The first to keep people in threat of foreclosure in their homes with loan modifications. And then a refinancing part of the plan for those who, like you, have been making all their payments on time and can continue to do so, but don't have the at least 20 percent equity in their homes necessary to refinance and lock in a lower interest rate. To qualify you must be not more than 5 percent underwater, meaning your mortgage is only 5 percent bigger than the current value of your home, and your loan must be backed or guaranteed by Fannie Mae or Freddie Mac, like 50 percent of American homeowners.
Head to FinancialStability.gov to get the qualifying paperwork and list of items you'll need to bring to your lender to apply. If you do not fall under those guidelines today, make note that the president's Housing Plan has a three-year term, so you may be able to apply next year or in the third year. And if you're much more than 5 percent underwater, you may have to stay put in your home until you have more equity to avoid PMI. Remember, PMI is insurance that mortgage companies ask you to pay to insure their investment in your home. When there's less than 20 percent equity in a home, lenders know that the loan is riskier, so they pass along the cost of this insurance.
Q: My husband and I are 30 years old. Together we have $13,000 in credit card debt at 8 percent interest and $65,000 in student loans at about 4 percent interest. We have a decent credit score and I am going to go back to school to get my master's degree while continuing to work. I will be eligible for student loans. Should I take out additional student loan money to pay off the credit cards?" — Casey, Kansas
David Bach: It's really a great question. If you look at it by just a numbers standpoint, it tends to make sense. The rate on a student loan is less than a high credit card — so take out a student loan to pay off the credit card and you swap a high interest rate for a lower one. But a lot of people just get themselves into more trouble. If you use new loans to pay off credit card debt, you don't get any better at just paying off your credit card each month responsibly. Mathematically, it makes sense, but the habit of pulling money out of your home or from student loans to pay off consumer debt is fundamentally wrong financial behavior. You want to avoid huge credit card debt to begin with. And you want to pay it off regularly. You cannot just pay the minimum. You have to pay off what you spend each month.
Student loans are actually supposed to be for student loan purposes. It's not supposed to be for other things. Don't treat it like a credit card for other things.
Q: We have been interested in buying a house. We both had some challenges in our 20s and managed to pay off all our credit issues. Now I really just need some advice on how we save for a house, pay all our monthly bills and improve our credit. We know that the First Time Home Buyer Tax Credit is only for this year so we won't be able to take advantage of that if we don't buy now. But we're worried that the housing market can keep getting worse over the next two years. Is it in our best interest to wait and keep renting? — Josephine, Florida
Carmen Wong Ulrich: Keep renting if only because it doesn't sound like you're ready. You need the 3 C's to buy a home: Great credit (sounds like you need more time to build this up); the capacity to pay the loan (solid income plus cash savings to cover several months of mortgage payments, after the down payment); and collateral (the down payment — hopefully of 20 percent). The best way to pay your monthly bills, improve your credit and save for the down payment (and first, an emergency fund) is to automate everything! Automate your banking completely. Bank online and set up automated payments for your bills (make sure you set the payments way before the due date so you leave plenty of time to meet the due date), as well as automated savings deducted from where your paycheck lands, going into a high-yield savings account or money market account. What you don't see in your checking account, you won't spend and won't be part of your monthly budget. By pay automating your bill-paying, you lessen the chances of being late on a bill and/or any bills slipping through the cracks. Just make sure you have a small cushion so no bills bounce.
Q: I was laid off from my job in December. I have been looking for a job, am on unemployment, and I have a son in his second year of college, on student loans. Our income has been cut almost in half. I have been all over the Web researching work-at-home businesses. Are any of these a legitimate and logical way to earn extra income?— Sharee
Jean Chatzky: They can be, but you have to be careful. There are a lot of sites out there looking to scam desperate job seekers, particularly now. Job opportunities that claim to allow you to make big bucks working from home, but ask you to hand over your credit card number, are a major red flag.
There are two Web sites I like for this: www.womenforhire.com and www.momcorps.com. Both offer work-from-home job listings, as well as other employment opportunities that may require some in-office face time. You can also look directly on the Web sites of large companies — many are offering work-from-home opportunities now because it cuts costs.
Finally, positions at direct sales companies like Tastefully Simple, Stella & Dot and Lia Sophia are really popular right now, and they largely seem to be recession proof. The New York Times had an article about this over the weekend, and reported that more and more sales consultants are signing on for the job. It's a great way to bring in cash while you're looking for a job, and the hours are flexible enough that you can continue with it part-time even after you've found a full-time position. Most sellers own a commission of 20-50 percent on their sales, depending on the company, by hosting in-home parties to sell everything from kitchen supplies to jewelry and food.
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